Department stores could go the way of the dodo

Global brands such as Ralph Lauren are a better bet: analyst

NEW YORK (MarketWatch) — With concerns that lower confidence and the expiration of payroll-tax cuts may curtail U.S. consumer spending this year, retail investors may be better off betting on global brands and curtailing exposure to department stores, an analyst said Wednesday.

“The expiration of the payroll-tax holiday is our main concern,” Macquarie analyst Liz Dunn said. “It’s very regressive and thus lower-end consumers will be hit harder.” She added that consumers have begun to save more in the fourth quarter amid declining confidence.

“Department stores are disadvantaged due to the focus on the domestic consumer, their relative maturity, the promotional models which they have propagated and the continuing pressure of share shifts to other channels,” the Macquarie analyst said. After having had to defend their share against specialty retail chains, they “will once again be left to struggle to defend market share — this time from online.”

At the same time, Dunn upgraded Ralph Lauren Corp.
RL, -1.54%
to outperform from neutral and continued to maintain her outperform ratings on global labels Coach Inc.
COH, -2.09%
and Fossil Inc.
FOSL, -1.29%

“After a difficult year of slowing international trends, Europe appears to be stabilizing and China growth remains strong,” according to Dunn. “Many companies will also be facing currency tailwinds where there were headwinds before.”

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The analyst singled out specialty-retail chains such as Francesca’s Holdings Corp.
FRAN, -2.95%
which she rates outperform, because of its unit-growth promise. Dunn said the chain is only about “40% built out” and is increasing square footage at more than 20% per year. Meanwhile, she upgraded Urban Outfitters Inc.
URBN, -0.46%
to neutral from underperform; Dunn expects the company to report solid holiday sales and sees its lower inventory helping to reduce profit-eroding markdowns.

Moderate model ‘may be broken’

In another trouble spot for department stores, their growing online focus will likely “cannibalize” sales in stores, Dunn observed. The chains “don’t have the flexibility that specialty retailers have to close stores or pull back on store-growth plans to fully capitalize on the growth in e-commerce,” she said.

Midprice operators like J.C. Penney and Kohl’s are getting squeezed in the middle. “The moderate department-store model may be broken,” she added. Penney’s “efforts to revive the channel haven’t worked; Kohl’s has been left with little but price to drive business.”

While Penney’s major merchandising and pricing overhaul under Chief Executive Ron Johnson could eventually succeed, Dunn believes it may take a lot longer than expected.

For Penney, “trends will improve in 2013, but the company has dug a pretty deep hole in 2012 and sales increases are not expected to come anywhere close to the amount that has been lost.” Read: Time to warm up to Penney yet?

Penney shares fell 3.1% in afternoon trading.

As for Kohl’s, the company was hurt by heavy discounting after a disappointing holiday season, according to Dunn. “Too much inventory has damaged margins but too little inventory could hurt sales,” she said, adding that Kohl’s already had three negative earnings revisions last year.

While Macy’s has had a streak of outperformance, the analyst expects its same-store sales to slow this year after three years of gains.

Dunn also said that she debated whether to “get more constructive” on Nordstrom Inc.
JWN, -0.88%
stock, which she rates neutral. While she said that consensus estimates on the retailer were too high, Nordstrom may be shielded from concerns about how upscale shoppers could be affected as a result of higher income taxes. Shares of Nordstrom rose 1% Wednesday.

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